CBRT on inflation dynamics


The Central Bank of Turkey has just published a very good and timely paper that explores inflation dynamics in Turkey.  The paper, among other things, documents nicely how dynamics of inflation have changed over the years, focusing on the period from 2006-2016, i.e. the 10+ years during which Turkey has been a formal “Inflation Targeter”.

The paper concludes that “[e]xchange rate and unprocessed food prices have been the main drivers of sharp changes in inflation from one year to another. Tax adjustments also create unpredictable movements. More interestingly, around 4 percentage points of inflation on average cannot be explained by standard macro variables in our sample period, suggesting the presence of more fundamental factors in explaining long term inflation process. This might be related to persistence in the pricing behavior due to expectation formation process as well as other structural factors which are not captured in our setup.”

Regarding policy implications, the paper also concludes that “the results reveal the crucial role of managing expectations as well as the need for a comprehensive approach to achieve price stability in Turkey” and that, “joint effort by all relevant institutions is needed to ease the associated trade-offs and achieve ultimate price stability.”

This is kind of fair, but I think the Bank is washing its hands of the whole thing — i.e. failing to hit the 5% target over the years — a bit too quickly.  It was interesting to note that nowhere in the paper the words “credibility” or “nominal anchor” are mentioned.  But the very lack of these things — for which the CBRT’s own policies and the very forgiving  language (toward politicians) are largely to blame — is arguably one major reason why inflation had that extra “4 percentage points” during this whole period (that “on average cannot be explained by standard macro variables”).

This also begets another tough question:  if these extra 4 pps. have been there for the last 10 years, what exactly would make it go away in the next few years, so that we could see inflation — finally — decelerate to the 5% target?

So a very timely and empirically rigorous paper indeed, that any observer of this economy should be grateful to Bank staff for producing it. Yet, it is also quite incomplete — to say the least — in its diagnosis. We understand that a more candid or a bolder diagnosis may be difficult to deliver openly and publicly, but we hope that the Bank is at least doing that behind closed doors, i.e. acknowledging that  high and sticky Turkish inflation “is always and everywhere a credibility phenomenon” (well, ok, largely so).